The Reason For An Income Tax Default (Form)

In Denmark, the government automatically prepares people’s taxes. Because they already have the data they need, the tax authority calculates everyone’s income taxes and sends them notice of how much they owe or will receive as a refund. With 80% of the population accepting its pre-filled tax return in 2011, Denmark minimized errors and the logistics of filing. They saved money and time for themselves and for the people who took the default.

Denmark’s tax story began in 1988. First, on paper, they send a partially pre-filled document and asked people to complete and return it. Within a decade, moving online, first they sent forms that were entirely pre-filled. The next step was a completed online form and then, after that, they concluded people might be even happier just getting an assessment. Involving a phone call or online reply, approval was simple.

In Nudge (a wonderful book), Richard Thaler and Cass Sunstein explained why we take the default. The path of least resistance, defaults require us to do almost nothing. And then, if they come with “some implicit or explicit suggestion that [they] represent the normal or even the recommended course of action,” defaulting becomes even more attractive.

With pre-filled tax returns satisfying every Nudge default criteria, you wonder why more countries aren’t providing them. Actually, Finland, Malta, New Zealand, Sweden and Norway do. But not the United States. In a 2006 paper, economist Austan Goolsbee proposed an Automatic Tax Return. Using it for people with very simple tax needs, he estimated that the policy could save us, as a nation, close to 225 million hours of tax prep time. Combine that with eliminating a $2 billion tax preparation price tag and you wind up with substantial savings.

Our bottom line returns us to incentives. It would be so nice if our lawmakers recognized the counterproductive incentives that regulations create. In his National Affairsarticle, “Kludgeocracy,” Johns Hopkins scholar Steve Teles says the reason is we keep adding new rules to existing rules and wind up with very messy laws that intentionally preserve the past (H/T econtalk.)

Sources and Resources: Always excellent, the Conversable Economistalerted me to pre-filled tax forms. Looking into it further, I found more about Denmark’s approach and was delighted that it all related to Nudge (quote from p. 85).